Belton Company is considering relaxing its credit standards to boost its currently sagging sales. It expects its proposed relaxation will increase sales by 20 percent from the current annual level of $10 million. The firm's average collection period is expected to increase from 35 days to 50 days, and bad debts are expected to increase from 2 percent of sales to 7 percent of sales as a result of relaxing the firm's credit standards as proposed. The firm's variable costs equal 60 percent of sales and its fixed costs total $2.5 million per year. Belton's opportunity cost is 16 percent. Assume a 365-day year.
a. What is Belton's contribution margin ?
b. Calculate Belton's marginal profit from increased sales .
c. What is Belton's cost of the marginal investment in accounts receivable ?
d. What is Belton's cost of marginal bad debts ?
e. Use your findings in parts (b), (c), and (d) to determine the net profit (cost) of Belton's proposed relaxation of credit standards. Should it relax credit standards?